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What's Going on with KIT Digital?

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[Editor's Note: The original version of this article reported that KIT digital had missed the second deadline for filing its 10-K for the 2011 period. The company did file on March 30 as promised, and the story has been updated to reflect that.]

KIT Digital was the talk of this year's National Association of Broadcasters (NAB) conference. At first, the talk was about the size of the KIT booth, a white double-decker in the upper floor of South Hall with multiple conference rooms and floor-to-ceiling windows. In a different location, it would have been a good starter home. It made a statement.

But as news spread, typically person-to-person, the topic shifted. "Did you hear about KIT Digital's chairman?"

Two weeks previous, on March 23, 2012, KIT made the not-so-surprising news that its chairman and CEO, Kaleil Isaza Tuzman, was resigning his CEO role. On April 16, he took the additional step of resigning as chairman.

With no information about his motives and tens of thousands of streaming professionals grouped in one place, the conversation quickly turned to rumor and gossip. Why, after going on an acquisition spree that built an end-to-end powerhouse of a company, would Tuzman suddenly relinquish it? Why would he do so only weeks after resigning as CEO? And why, if he had any choice in the matter, would he do so on the first day of NAB?

New Challenges, New Roles

Could it all have been for the good of the company? That's the suggestion of KIT's own top brass, who come across as tight-lipped and embarrassed by the attention when asked.

"I would complement him for having the vision for accomplishing what he accomplished up to this point. Now is a time when we will solely focus on executing on the huge marketing opportunities that the company has," says Alex Blum, KIT's chief operating officer.

Blum refers to Tuzman as a "lightning rod," a characterization taken from Tuzman's own note on relinquishing his CEO role: "I'm some of you (sic) I'm sure will be happy to hear this, given that I'm kind of sometimes a lightning rod personality, and it's a love him or hate him type of dynamic -- from a public market perspective, I'm going to take a step back in some of that interaction, and I think really enable the company to get to its next level of development from a communications perspective in the market."

"Lightning rod" may not be the best characterization, implying a victim rather than someone who created his own controversies. Tuzman's colorful personality first came to many people's attention in the 2001 documentary Startup.com. The Wall Street Journal reported on November 26, 2011, that Tuzman had been arrested in Dubai after a dispute with a lawyer, an allegation that the company strongly denied. Even more recently, the SEC has subpoenaed KIT Digital and Tuzman in an official investigation.

"Our company and Mr. Isaza Tuzman have been required to produce documents to the SEC under two simultaneous February 24, 2012 subpoenas issued by the SEC. The investigation includes and we believe may focus on June 2010 transactions in company common stock and a related Form 4 filing by Mr. Isaza Tuzman that reported a purchase of 54,645 shares of company common stock, but we cannot be certain of its scope or outcome," KIT disclosed in its 2011 10-K.

For a global company with a market capitalization of over $400 million, KIT appears to have been careless in its financials. As a recent Motley Fool article on Daily Finance documents, sometime between its Q4 reports and its 2011 10-K, $2.14 million in cash went missing. The article also notes that cash was improperly being held overseas, which violated its lending terms, and it advised investors to be cautious around KIT, calling it "a downright risky proposition."

Attempting to shake the conspiratorial air already forming around his company, Murray Arenson, KIT's senior vice president of corporate initiatives and investor relations, characterizes the legal issues as little more than a speeding ticket: KIT and Tuzman received subpoenas related to transactions that Tuzman undertook regarding roughly 55,000 shares of stock; Arenson says they answered the requests, and the whole matter should be completed shortly.

As for the issues that led to Tuzman's resignation, Arenson sees it as an ordinary transfer of power.

"One, it's natural for a company that grows aggressively to have a enterprising visionary leader, to have a leader like Kaleil at a certain state of time," says Arenson. He denies that Tuzman's departure was sudden, saying that it had been a subject of in-house discussion for between 12 and 18 months.

"I view it as a transition, and a transition that happened in a pretty short time frame," says Arenson. He describes Tuzman as a visionary and an entrepreneur, saying that in general a different skill set is now needed to run the company.

The departure certainly doesn't mean that Tuzman will no longer play a role in KIT's future. He's still a major stockholder, Arenson confirmed. Working from the outside, Tuzman could now enjoy more freedom in directing his company than before.

KIT Digital's Tangled Finances

Anyone keeping an eye on KIT Digital's financials probably saw the resignation as a good sign, an indication that KIT was going to pay more attention to filings and investor relations before things spun out of control even further. The company delayed filing its current 10-K, for example, and then missed that new deadline before finally filing before filing it on March 30. Delaying a 10-K is a red flag for Wall Street.

Between Tuzman's March and April resignations, four board members resigned. Even more seriously, KIT waited five days after Tuzman's resignation to notify shareholders. His letter to the board was dated April 11, and said that April 11 was his last day. The company's press release went out on April 16.

Diving into the books raises more concerns. KIT still doesn't generate positive free cash flow. Its free cash flow was negative $23 million for 2011. That means that after 15 headline-making acquisitions (including Hyro Limited, acquired today), the company isn't yet close to making money. KIT is also burdened with $20.8 million in debt and has less than $47.8 million cash in the bank. After several rounds of funding and stock dilution, it may find raising cash difficult in the future.

"They told Wall Street they were done raising money, but shortly afterwards went out and raised $102 million. They have been saying for years they were in talks to be acquired and hold that hope over investors' heads, but that's not come to fruition. With the problems they have shown with accounting, the fact no one really knows how they account for SaaS-based revenue due to bundled contracts, it's also hard to believe what their real margins are. The bottom line is that Wall Street stopped trusting KIT a long time ago, customers don't know who they are and what their focus is, and it's hard enough to integrate one acquisition, let alone fifteen," says StreamingMedia.com executive vice president and Frost & Sullivan principal analyst Dan Rayburn.

The company's lack of research and development spending is also cause for concern. While it has acquired 15 companies and has more than 10 platforms to integrate, it spends little on R&D. According to its latest 10-K, it spent $15.1 million on R&D in 2011, when it had revenues of $215 million. Compare that to Brightcove, which had revenues of $60 million in 2011, yet spent $15.3 million on R&D.

The company's reporting also seems sketchy. For example, last year it reported that the overall market was worth $430 million and that it had a 35.6 percent market share. That sounds great, but KIT didn't provide any third-party data to back up its claim. It uses the abbreviation VAMS, for video asset management solutions market, a term that it created and that no one else in the industry uses. Wall Street has trouble believing how much of the industry KIT serves when it lacks analyst confirmation and creates its own definitions.

"The biggest problem is that KIT digital never had any real focus with customers, with Wall Street, or with their product portfolio," says Rayburn. "Through the acquisition of fifteen different companies they offer dozens of products and services to multiple verticals in multiple countries, yet never excelled at any one thing. They target the enterprise, media and entertainment, broadcasters, and MSOs, but then also count hundred of churches as customers. There has never been any real synergy amongst their customer base or the products they offer.

"I don't see KIT surviving in the market in their current state. The company will have to downsize, focus on just a few services and verticals, and try to convince customers what they are good at. As for Wall Street, most of them no longer look at KIT as a long-term investment, unless they are trying to short the stock," asserts Rayburn.

The Community Responds

Tuzman's fellow chief executives seem to agree that his resignation was largely a matter of differing skill sets and a colorful CEO who invited too much unflattering attention.

"I have no reason to believe other than he was a lightning rod and their stock has been pummeled because of that. Unless we're all missing something, I doubt there was any thinking of an NAB-effect. There's no right time in this situation," notes Sorenson president and CEO Peter Csathy. A lightning rod, he adds, isn't what KIT investors are looking for.

"It's not surprising that this has happened, because investors need a cogent story and need a leader who was accepted by the street," says Csathy.

While expressing his admiration and respect for Tuzman as a formidable player in the space, Csathy admits that the piecemeal style of the resignation is odd, and that the timing of the announcement is surprising. He believes that the move is intended to polish KIT's image, not just for investors, but also for a future buyer.

"There's no mystery that KIT's ultimate goal always was to be acquired," asserts Csathy. Indeed, another global CEO, who declined to be quoted in this story, said he was certain that KIT is actively seeking a buyer.

While he hadn't heard about a possible acquisition, Sam Blackman, CEO and co-founder of Elemental Technologies, doubts that that would be a factor in Tuzman's resignation.

"Companies are acquired because they have great technology and market traction. You're not going to be acquired or not acquired unless the CEO is actively against it," says Blackman. "I don't think that whether Kaleil was running the company or not would have impacted whether they wanted to be acquired."

Blackman also believes the transition, while sudden, is simply a matter of skill sets.

"I think it was a very aggressive strategy, the acquisition phase of that strategy takes one type of skill," says Blackman, adding that integrating those companies may take a different set of skills. "I think it's a fairly natural transition that you see in a lot of companies."

Tuzman is seen as the opposite of conservative, Blackman notes. Certainly, conservative is something that shareholders or possible buyers are now looking for. So how did Wall Street react to these months of surprising shifts?

Word on the Street

It's clear that KIT Digital took to heart the essence of a November article in The Wall Street Journal that not only referred to Tuzman as a "colorful character" but also questioned the transparency of the company's financial statements and dealings as it snapped up 15 digital media companies over the past three years.

The market reacted slightly to the news of Tuzman's departure, with the stock price dropping about 3.4 percent in after-hours trading. Shortly after the Journal article was published in November, the company's stock dropped to just about $8 per share, then shot up for a few days to over $12 per share.

Looking into the stock's movements, according to historic data available on Yahoo Finance, trading volumes at the low point of the November stock value were averaging about 400,000 shares traded per day, with an increase to about 750,000 right after the Journal article appeared. Within the next few days, it would be natural to assume that trading volume would return to normal and the stock price would decrease on the news. Yet just the opposite happened: both the stock price and trading volumes skyrocketed, with the price moving from $8.03 to $12.37 in less than four days, and daily trading volumes jumping to almost 5.8 million shares in less than two days. Clearly someone was moving the stock back to a higher level.

Trading volumes continued to stay heightened for the following week, even as the stock dropped back to $8.70 over the next two weeks, with several days of trading volume at 1.25 to 2.1 million. The pattern repeated itself in a staggered pattern through late January and early February 2012, as the stock moved back up to a high of $12.47 per share, although the daily trading volumes were within a tighter range (1.0 to 1.5 million) and were interspersed between days where trading volumes were much closer to the daily average of 400,000 shares.

Again, however, even the large trading volumes could not keep the stock aloft, and the stock took a few hits on large trading volumes, falling to $8.51 on March 15 on a trading spike of 4.6 million shares traded and then dropping off precipitously the day Tuzman announced he was stepping down as CEO.

While Tuzman said in an interview with TheNextWeb that he'd planned to transition from CEO to the board chairman position, the stock impact of the March 23, 2012, announcement date paints a different picture. Historic trading data shows that March 23 marks the biggest share sale to date -- trading volume that exceeded 12.2 million shares -- and corresponded with the lowest share price within the past four years. KITD shares plunged to $6.33 per share from the previous day's close at $8.15 per share. In other words, on trading volumes that were over 30 times that of the average daily trading volume, the stock lost almost 30 percent of its value in a single day and almost half its value from one month prior.

No doubt, many of us will be closely watching KIT in the near future, both to see if there's fire behind the smoke of an SEC investigation, and to see if Tuzman's departure leads to a more conservative outlook for KIT -- and possibly a new buyer as well.

This article contains additional reporting by Tim Siglin.

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